Germany faces a terrible dilemma. Either Europe's paymaster agrees to underwrite a Greek bail-out and drops its vehement opposition to a de facto EU economic government, treasury, and debt union, or the euro will start to unravel, and with it Germany's strategic investment in the post-war order.

The spike in yields on 10-year Greek bonds to 400 basis points above German Bunds has been shockingly swift – a warning to Britain, too, that markets can suddenly strike any country that takes creditors for granted.

We can argue over whether Greece, Portugal, or Spain are at risk of being forced out of the euro. But there is another nagging question: whether events will cause Germany and its satellites to withdraw, bequeathing the legal carcass of EMU to the Club Med bloc.

This is the only break-up scenario that makes much sense. A German exit would allow Club Med to uphold contracts in euros and devalue with least havoc to internal debt markets. The German bloc would enjoy a windfall gain. The D-Mark II would be stronger. Borrowing costs would fall. The North-South gap in competitiveness could be bridged with less disruption for both sides....

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February 3, 2010 - 9:24PM The Greek prime minister ordered a public salary freeze, a higher retirement age and a hike in petrol prices in a desperate bid to tame a debt crisis ahead of a verdict Wednesday on his efforts from the EU.

Socialist leader George Papandreou urged political rivals to back his crisis budget as he launched a new bid to reassure the international finance community. The scope of Greece's debt and its 12.7 percent public deficit have shaken the euro and put pressure on Greek sovereign bonds.

"We must act in an imminent and efficient manner and it is for that reason that I called on the political parties to support this national effort," he said in a nationally televised address late Tuesday.

"It is a national duty not to leave the country on the edge of an abyss."

The government has already ordered major cuts in public spending and vowed to clampdown on corruption which Papandreou has admitted is "rampant", waste and tax avoidance.

Among the new measures was a total freeze on the salaries of public servants, a rise in the legal retirement age and a higher petrol tax. He gave no details on the retirement age or tax rises.

The Greek plan sent to the European Union only foresaw a freeze on wages above 2,000 euros a month and the same age for men and women retiring.

The European Commission will on Wednesday give its verdict on Papandreou's measures to cut debt estimated at 294 billion euros (412 billion US dollars) and to cut the deficit to 8.7 of gross domestic product this year.

Under EU rules, government deficits have to be below three percent to be a member of the euro zone.

European Commission chief Jose Manuel Barroso said on Tuesday that Greece's programme was "feasible but subject to risks". He said the commission would recommend that the EU endorse the Greek plans, though keep the country under "intense surveillance".

"A deficit of such a magnitude must be decisively corrected. Moreover the government debt in Greece is excessively high," he said.

Right-wing opposition chief Antonis Samaras and the far-right indicated they would support the measures, but the radical left and the communists opposed them, saying they "serve the speculators".

The Greek media called the new austerity measures "hardline".

The pro-business Kathimerini daily said Papandreou had been forced to act by the "asphyxiating pressure of the markets". The left-wing Ethnos daily ran a front page headline saying: "Shock Measures Ordered by Brussels".

EU approval of the budget would help ease market pressure on Greece, which has grown drastically amid investor doubts about the government's ability to tackle the debt.

The yield gap or spread between Greek and German bonds, which are considered the safest in the eurozone, last week hit the highest levels in a decade.

Greece is among a growing number of EU countries hit by growing debt and Papandreou expressed support on Tuesday for the idea of a eurozone government bond.

"Eurobonds could be used to lend member states at a lower spread, a lower interest rate compared to the international market, particularly in this environment of speculation," he said at a conference in Athens.

"When Greece talks about eurobonds it unfortunately works negatively, it is seen as a weakness. The issue of the bonds will hopefully happen," he said.

At the conference, Nobel-winning economist Joseph Stiglitz, a former chief economist at the World Bank and an adviser to several governments hit by the economic crisis, called for a system to aid debt-hit EU states.

"(There is) a lack of European macroeconomic structure to help countries with particular difficulties," he said, noting that in the United States the national budget can be used to help states in trouble.

While the European Central Bank regularly lends money to national banks at interest rates lower than the international market, the same option is not available to governments, Stiglitz said.

Spain is going through a "deep crisis" in its housing sector. Photo: AFP Julian Callow from Barclays Capital said the EU may to need to invoke emergency treaty powers under Article 122 to halt the contagion, issuing an EU guarantee for Greek debt. “If not contained, this could result in a `Lehman-style’ tsunami spreading across much of the EU.”

Credit default swaps (CDS) measuring bankruptcy risk on Portuguese debt surged 28 basis points on Thursday to a record 222 on reports that Jose Socrates was about to resign as prime minister after failing to secure enough votes in parliament to carry out austerity measures.

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Trichet said the “solidity” of the euro area “is not necessarily very well known” and its situation compares “very flatteringly with a number of other industrialized countries.” He said that according to the International Monetary Fund, in 2010 the average deficit for the entire euro region should be around 6 percent of GDP.

“Can I mention what it is for other major industrialized countries,” Trichet said. “The U.S., a little bit more than 10 percent, Japan, a little more than 10 percent, and you can find out other industrialized countries that are even higher than 10 percent.”

SPONSORED BY Speculators have begun betting on an early euro-zone exit by Greece, a politically corrupt, basket-case country that has long cooked its government-debt figures and now faces years of stagnation—if not deflation and depression—as it slashes public deficits and shrinks wages in an attempt to regain competitiveness. In a confidential paper leaked last month, the European Commission warned that "imbalances" between stronger and weaker euro states risk the very existence of the euro itself.

SUBSCRIBE Click Here to subscribe to NEWSWEEK and save up to 88% >> They are wrong. Currency unions don't collapse because weaker members leave them. Were Greece to start printing new drachmas, they would immediately plummet in value against the euro. A super-weak drachma would make Greek wines and vacations very cheap for foreigners, but that gain for Greek competitiveness would be more than offset by bank runs, rampant inflation, and the burden of having to pay back old euro-denominated debts and mortgages with a newly worthless currency. Even if Greece's inept political class decides to take the risk—not unthinkable, since it might be a way to shift blame to outsiders—it would not break the euro zone. The euro would hardly be less stable without Greece, or even without Spain and Portugal. (Together, the three make up only 18 percent of euro-zone GDP.) On the contrary, a euro centered on Germany, France, and a few of the more advanced Central European economies like Poland would make the union stronger, not weaker. The risk of this is not so much the result but the financial and political upheavals in getting there.

The euro zone would break up not when weaker members leave, but when stronger ones no longer see gains from the arrangement. Today, that cornerstone is Germany. Europe's largest economy has emerged from the crisis bruised but with comparatively healthy public finances and an economic model unquestioned by its people. With the German political class so thoroughly invested in the common currency—and German companies dominating Europe more than ever—that scenario seems highly unrealistic.

On the contrary, Germany is working hard to impose its monetary and fiscal discipline on the rest of Europe. At home, it already has a new constitutional amendment prohibiting deficits starting in 2016. Chancellor Angela Merkel vetoed EU bailouts of weaker economies, forcing countries like Latvia and Hungary to seek the tough love of the IMF. The Frankfurt-based European Central Bank, unlike America's Federal Reserve, has a strict inflation-fighting mandate and is prohibited from using monetary policy to jump-start the economy. It has pumped far less money into the EU economy than the Fed has done in the U.S., even at the cost of allowing the euro to rise against the dollar by 20 percent since the start of the crisis. ECB chief Jean-Claude Trichet has told Greece that it must reform on its own, and denied there would be a bailout. Now Merkel is pushing to install German Bundesbank chief Axel Weber to succeed Trichet when his term ends next year to make sure the ECB doesn't soften its course.

As the focus of the economic crisis shifts from the financial to the public sector, there will be more risk and pain. In Latvia, whose currency is pegged to the euro, slashed public spending has accelerated the country's path to depression; GDP is down 24 percent in the last two years. Ireland, which is paring back its deficit with across-the-board cuts in civil-servant salaries, has seen GDP slide by more than 8 percent in the same period. Back in Greece last week, farmers rioted against a planned freeze in their subsidies.

It's no accident that the countries with bubble and deficit problems have also lost labor competitiveness, especially within the euro zone. Ireland, Spain, and Greece have let their wages rise about 20 percent faster than Germany's since the euro's introduction. With Germany now so much more competitive, it has accumulated China-style trade surpluses with weaker euro-zone members. Without the currency safety valve, those countries will have to make deep wage cuts, along with tough product- and labor-market reforms that help raise productivity.

Working out these problems could leave Europe stronger as a political institution. Just as the Great Depression forced the U.S. to impose a tighter federalism, today's economic crisis will likely force Europe into a closer union. Already last week, the EU Commission began pushing reforms on Greece. Through the back door of an economic crisis, the euro zone might then get the kind of political governance that skeptics always warned was necessary for a currency union to work. At the end of the tunnel could be a more integrated Europe, reformed problem economies, and ultimately a more competitive Europe.

May be Trichet is right and the euro is solid and strong but not many know about it....

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How does Germany leaving the Euro erase the debts of another nation? It doesn't.

If Germany left the Euro the entire EU would collapse. It doesn't take a bailout to fix the mess. It takes Greece (and all others) to become a proficient nation to fix the mess.

May be the difference bewteen australia and EU is that if a state over here get into debt trouble kevin or the PM at the time can choose to bail it out (probably same thing with US), this is even if some state is against it. In europe and EU any membar can veto any bailout, and EU central bank doesn't have pumping up growth as mandate but just inflation and economy stability

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Whats competency as a nation (how do you define it?) got to do with balancing budgets, wage restraint and reducing trade deficits?

Germany has a recent history of marching on its neighbours (although getting defeated every time). In comparison I think cutting themselves off and resurrecting the DM is small bananas if a 30s depression unfolds.

On another point, lets see if the NPD can raise its membership from 7000 and win a seat in the Bundestag in 2013. It will be a good measure of public feeling. Loony right always do well in bad times.

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yeah i liked the bit about greece leaving the UE as being a good thing for the EU and bad for greece. sure makes for less temptations to try a dummy spit at any meetings. " ok bye dont let the door hit your ass on the way out, CUZ I NOW OWN YOUR ASS AND I DONT WANT IT DAMAGED. "

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Christine Lagarde welcomes the Euro tanking (this comes after the Swiss Central Bank shorted its own currency of Friday)...

IQALUIT, Nunavut (Dow Jones)--French Finance Minister Christine Lagarde Saturday welcomed the strengthening of the U.S. dollar, suggesting that recent developments could ease tensions that have long-burdened European economies because of a strong euro. She also stressed the commitment of euro-zone members of the Group of Seven to closely monitor efforts by Greece to mend its public finances, as public debt worries have roiled markets in recent days.

"We always complained about the dollar not being strong enough ... That is clearly an improvement," Lagarde told reporters after a G-7 meeting that was held in Iqaluit, Northern Canada, on Friday and Saturday.

The dollar has recently risen against the euro, which last week took a beating on the back of continued worries over the state of Greece's public finances and other highly indebted European nations such as Spain and Portugal. As the financial crisis pushed the euro higher against the dollar last year, French officials have repeatedly bemoaned the weak dollar, saying a strong euro hurts European exports.

The French finance minister's remarks came as the G-7 said Saturday it was sticking to an earlier stance on currencies laid out at a previous meeting in Istanbul, Turkey, in October. The Istanbul statement said excessive currency volatility has an adverse impact on financial stability, and welcomed efforts by China to move to a more flexible exchange rate regime.

Lagarde said that the G-7 still has a role to play in monitoring foreign exchange fluctuations, despite concerns it is becoming irrelevant due to China not being a member and to the growing importance of the Group of 20 as the world's primary forum for economic discussions.

"I am not sure that the G-20 is currently the right forum to discuss currencies...which is one of the reasons why we think the G-7 is a good forum to keep, even in a renewed format," Lagarde said.

French President Nicolas Sarkozy has vowed that ending the current "monetary disorder" will be one of the G-20's main tasks when France chairs the group next year.

The French finance minister repeated earlier assurances made at the G-7 meeting by European Central Bank President Jean-Claude Trichet that the group's euro-zone members will keep a close eye on how Greece implements plans outlined to fix its finances.

"Euro-zone members of the G-7 have confirmed the substance and the significance of the plan put together by Greece and that they will make sure that the plan is managed," Lagarde said.

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Quite crappy analisis this one on zerohedge (I would sack the writer or send him to economy lessons).

Specially the last bit is wrong, you can't make statement on country external funding needs on government budget debt (what about Japan then?), you have to consider the total debt private + public as a whole and only after that look at the current account numbers. I am pretty sure those public budget increase are compensated by private savings and a drop in gdp that was 4% in EU last year. Also, when you look at europe account numbers you can't just consider the internal spending as the main player, in europe as a whole price of oil or gas is a great player and a drop in those prices would turn account figure around in most euro country.

Also about M3 I don't think is that bad in EU considering 4% gdp drop, no population increase, irrelevant quantitative easing, even in australia you have a sick m3 with population increasing and even with home prices/private loans still rising.

then you can't put eu country in group like south west, east etc. each country is very different to each other, for example, spain and greece are in a very different situation then italy or france, iceland and UK very different then ireland, etc.

<br clear="all"> Feb. 9 (Bloomberg) -- “You never want a serious crisis to go to waste,” Rahm Emanuel, U.S. President Barack Obama’s chief of staff, said during the 2008 credit crunch. “It’s an opportunity to do things that you could not do before.”

Somebody should phone the White House, and ask if Emanuel could be flown to Frankfurt for a few weeks.

The euro area and the European Central Bank are now dealing with what markets are calling the “PIGS” crisis: Portugal, Ireland, Greece and Spain. Sometimes Italy is added to the list, but its finances seem to be in slightly better shape.

The bond markets have picked on Greece, punishing the country for running up a budget deficit equal to 12.7 percent of gross domestic product. Now the focus is on other indebted countries in the euro area. Equity and currency markets are jittery as central bankers seek a lasting solution.

It’s a crisis, no doubt. But the ECB should, perhaps, see it as an opportunity.

There has been confusion about fiscal responsibility since the euro was created a decade ago. This is the chance to set the record straight. Get this crisis right, and the euro could establish itself as the dominant world currency. Get it wrong, and by 2030 the only place you’ll be able to get euro notes will be as souvenirs on EBay Inc.

The nub of the PIGS problem is very simple: For years, they have been able to incur debts in a currency that was far stronger, and had much lower borrowing costs, than the old national ones the euro replaced. Now the bill is falling due. Either they implement tough austerity measures, subjecting their economies to savage recessions. Or else they can quit the euro and introduce a new currency. Either way, the outlook is grim.

There is, however a three-step program, that would manage the crisis and strengthen the euro in the long term.

Here’s what the ECB, with the backing of the euro-area governments, needs to do:

Step 1: Stand firm and refuse to offer a bailout.

The bond markets have been assuming that lending to the PIGS was much the same as lending to the U.S. or Japan. In the end, the central bank would always rescue them by printing more money. That was a big mistake.

Explain politely that nobody ever said that was how the euro would work. If you lend money to Greece or Portugal, you have to take a good look at that economy and reach a decision on whether the bond can be repaid, much as you would when deciding whether to buy a bond from Volkswagen AG or BP Plc. Corporations rarely get bailed out by central banks, and they can’t devalue their currencies either. Within the euro area, the bond market needs to start functioning much more like the corporate-debt market, with each borrower assessed on its own merits.

Step 2: Organize an orderly default.

It’s not going to be possible for the PIGS to meet their obligations. The debt burden is simply too great, well above the euro-area limit of 3 percent of GDP: Portugal’s 2009 budget deficit was 9.3 percent; Ireland’s was 11.7 percent; and Spain’s was 11.4 percent.

If governments slash spending too much, they will drag their economies down too far and too fast. Tax revenue will collapse, making it even harder to repay the debts. They will just get sucked into a vicious circle.

There is a lot of pain to go round, and there is no reason why the bondholders shouldn’t share some of it. Companies default on their bonds all the time. So do countries. The PIGS, under the guidance of the ECB, should simply declare a debt restructuring: They can announce a temporary suspension of interest payments, and offer bondholders 50 percent of their money back. It is precisely what would happen if a company was struggling to pay back its debts. There’s no reason a euro-area country shouldn’t do the same thing. So long as it is done in a controlled way, the situation is manageable.

Step 3: Create a mini-IMF.

In much of the world, the International Monetary Fund is called in when a country gets into a financial mess. It organizes a bailout, and effectively takes control of the nation’s economic policies while a rescue package is put in place. The ECB needs to do something similar. If Greece or Portugal defaults on its bonds, it will be hard to raise funds.

In that situation, the ECB should provide bridge loans to get countries through the crisis, in exchange for imposing emergency economic reforms. That will include cuts to state spending and taxes, and rolling back regulations so that economies can grow again. As the IMF has proved, it is often a lot easier for an outside body to impose tough changes than it is for locally elected politicians.

Countries can claw their way back from a fiscal meltdown. The Irish have made a great start, cutting public spending dramatically, while holding corporate taxes down. In effect, they are swapping short-term pain for long-term gain, which is always a lot better than doing it the other way around.

When the euro was introduced in 1999, it wasn’t clear whether member states would have to bail each other out and whether economic policies would be imposed from the center.

Those questions should now be answered decisively.

The euro can’t survive if members can accumulate huge debts and get other countries to pick up the bill. And, when necessary, there needs to be tough economic medicine imposed by the ECB. The PIGS crisis is a chance to address those two points. The common currency will emerge stronger as a result.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

Click on “Send Comment” in the sidebar display to send a letter to the editor.

My opinion is that is a bit too early to call a default on the PIGS debt, for example I think Ireland is going to make it (same for Italy that despite the GDP fall has got around 5.5% of GDP budget deficit).

The risk of calling the default is that money flow into the country stop (forcing budget to even up straight away) and very luckily you send bankrupt the local banks and many businesses (that also will default on debt), money to businesses will also freeze, I believe you would have to expect 10% GDP drop straight away for those country that default on debt.

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Germany is preparing to drop its vehement opposition to a rescue package for Greece, fearing that a rapid escalation of the debt crisis in Southern Europe could endanger German banks and damage the euro.

Wolfgang Schäuble, Germany's finance minister, has asked officials to prepare a plan in time for a summit of EU leaders on Thursday, according to reports in the German media. The options include either a loan from EU states or some sort of institutional EU response.

The news pushed the euro to $1.38 against the dollar, the strongest one-day rally since the single currency began its nose-dive late last year. Yields on Greek 10-year bonds plummeted 36 basis points to 6.39pc in a matter of hours as speculators scrambled to exit overstretched positions, with synchronised moves for Portuguese, Spanish, and Italian bonds.

Michael Meister, parliamentary chief for Germany's Christian Democrats, said the crisis could not be allowed to drag on. "Our top priority is the stability of the euro," he told FT Deutschland. "Should Greece receive help, it will only be under tough conditions and if the Greek government undertakes root-and-branch reforms."

Germany's apparent backing for a bail-out comes despite worries that it will lead to the breakdown of fiscal discipline across the Club Med region. It also raises troubling questions of fairness. Ireland has tackled its own crisis by slashing wages and going far beyond any measure so far offered by Greece, yet Dublin has not received help.

Germany's dramatic shift in policy changes the character of the euro project. It follows weeks of soul-searching in Berlin, and after increasingly loud pleas from Brussels, Paris and southern capitals. The deciding factor was concern that letting Greece fail risked a "Lehman-style" run on Club Med debt, with systemic spill-over across Europe.

German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan.

The breakthrough comes as this week's summit of EU leaders in Brussels rapidly evolves from a policy workshop into an historic gathering that may catapult the EU across the Rubicon towards fiscal federalism and a de facto debt union. The EU's top brass are seizing on the crisis to push for a radical extension of EU powers, saying Greece has exposed the deep flaws in the structure of monetary union.

Herman Van Rompuy, the EU's new president, has submitted a text calling for the creation of an "economic government" that shifts responsibility for economic planning from national authorities to the "EU level".

In a parallel move, Commission chief Jose Barroso said Brussels has treaty powers allowing it to take the reins of economic management. "

This is a time for boldness. I believe that our economic and social situation demands a radical shift from the status quo. And the new Lisbon Treaty allows this," he said.

"Economic policy isn't a national, but a European matter. No modern economy is an island. When a member state doesn't make reforms, others suffer because of that."

Rumours swept the markets all day on news that Jean-Claude Trichet, the head of the European Central Bank, had cut short a trip to Australia to attend the summit.

It is unclear how long Tuesday's reprieve will last, or whether any bail-out involving loans – as opposed to subsidy – can solve the deeper crisis of Club Med competitiveness. Wealthy Greek citizens have shifted €7bn from banks in Greece to foreign accounts, fearing that capital controls in Athens. The withdrawals have echoes of the Mexico's Tequila Crisis in 1994 when Mexicans set off a spiral by shifting funds to the US.

The risk is that capital flight will erode the deposit base of Greek banks, forcing them to shrink loan books. Greek banks do not rely on the fickle funding of wholesale markets – the undoing of Northern Rock – but this does not shield them from a deposit run.

Goldman Sachs has downgraded the National Bank of Greece and GPSB. "Greece faces both a liquidity and, potentially, a solvency problem. While we believe that, individually, Greek banks tend to be well-run, the problems they face are outside their operational control," it said.

Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country's already bloated deficit.

Greeks aren't very welcome in the Rue Alphones Weicker in Luxembourg. It's home to Eurostat, the European Union's statistical office. The number crunchers there are deeply annoyed with Athens. Investigative reports state that important data "cannot be confirmed" or has been requested but "not received."

Creative accounting took priority when it came to totting up government debt.Since 1999, the Maastricht rules threaten to slap hefty fines on euro member countries that exceed the budget deficit limit of three percent of gross domestic product. Total government debt mustn't exceed 60 percent. The Greeks have never managed to stick to the 60 percent debt limit, and they only adhered to the three percent deficit ceiling with the help of blatant balance sheet cosmetics. One time, gigantic military expenditures were left out, and another time billions in hospital debt. After recalculating the figures, the experts at Eurostat consistently came up with the same results: In truth, the deficit each year has been far greater than the three percent limit. In 2009, it exploded to over 12 percent.

Now, though, it looks like the Greek figure jugglers have been even more brazen than was previously thought. "Around 2002 in particular, various investment banks offered complex financial products with which governments could push part of their liabilities into the future," one insider recalled, adding that Mediterranean countries had snapped up such products.

Greece's debt managers agreed a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002. The deal involved so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period -- to be exchanged back into the original currencies at a later date.

Fictional Exchange Rates

Such transactions are part of normal government refinancing. Europe's governments obtain funds from investors around the world by issuing bonds in yen, dollar or Swiss francs. But they need euros to pay their daily bills. Years later the bonds are repaid in the original foreign denominations.

But in the Greek case the US bankers devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $1 billion for the Greeks.

This credit disguised as a swap didn't show up in the Greek debt statistics. Eurostat's reporting rules don't comprehensively record transactions involving financial derivatives. "The Maastricht rules can be circumvented quite legally through swaps," says a German derivatives dealer.

In previous years, Italy used a similar trick to mask its true debt with the help of a different US bank. In 2002 the Greek deficit amounted to 1.2 percent of GDP. After Eurostat reviewed the data in September 2004, the ratio had to be revised up to 3.7 percent. According to today's records, it stands at 5.2 percent.

At some point Greece will have to pay up for its swap transactions, and that will impact its deficit. The bond maturities range between 10 and 15 years. Goldman Sachs charged a hefty commission for the deal and sold the swaps on to a Greek bank in 2005.

The bank declined to comment on the controversial deal. The Greek Finance Ministry did not respond to a written request for comment.

Yields on Greek debt rose by 14 basis points, as investors digested the fact that G7 and eurozone finance ministers refused at their weekend summit to provide more detail on a rescue package for the troubled economy.

Alongside Portugal, Spain, Italy and Ireland, Greece has been the focus of widespread market selling over the past few weeks, with investors fearing the countries may be unable to repair their balance sheets alone. The interest rate on Greek 10-year benchmark debt is now 6.75pc, compared with fellow euro member Germany’s rate of 3.14pc.

Suspicions that the Greek crisis could give way to a full-blown attack on the euro have been reinforced as it emerged that currency speculators have increased their bets against the currency to the highest level since its creation.

Contracts on the Chicago Mercantile Exchange (CME), a closely-watched speculation barometer, showed that in the past week net short positions against the euro rose from 39,500 contracts to 43,700 – worth €5.5bn ($7.5bn). Greek prime minister George Papandreou has characterised the behaviour of capital markets, which have put a rising premium on interest rates to his government, as part of a broader speculative attack on the currency.

The CME figures will spark fears that, much like George Soros in the early 1990s, hedge funds will lay siege to the single currency. Since Greece, Portugal, Spain and Italy, all of whom are facing similar issues, cannot devalue or inflate their way out of the crisis, economists suspect that they will have to receive assistance from other euro nations to avoid inflicting cuts of unprecedented ferocity on their economies.

Economist Joe Stiglitz, who is advising the Greek government, last night denied that the country would require a bail-out, and urged national authorities to intervene in markets to "teach the speculators a lesson". Likening the situation to the Asian financial crisis, in which even healthy economies were targeted as hedge funds and investors withdrew from the region, he told the Sky's Jeff Randall Live show: "The speculators will always look for the weakest link. What they're doing now is a version of the Hong Kong double play in 1997 /1998.

"What Hong Kong did in response was to raise interest rates and intervene in the stock market. They burnt the speculators and Europe needs to do the same thing."